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Welcome to Money For the Rest of Us, our personal finance show on money, how it works, how to invest it and how to live without worrying about it. I’m your host, David Stein, and today is episode 171. It’s titled “The Extraordinary Impact of Cities.”

200 years ago, in the U.S., only 4% of the population lived in cities. Today, it’s 80%. In 2006, for the first time, half the world’s population lived in cities, and that compares to only 15% 100 years ago, and 30% in 1950.

China expects to move 300 million individuals to cities in the next 10-25 years. That’s equivalent to almost the entire population of the United States. Now, one of our cities in our country, the fourth-largest city, Houston, is suffering right now. Hurricane Harvey – a devastating calamity in terms of the flooding… 250k to 500k cars are estimated to have been damaged, and the vast majority of who knows how many houses in terms of flood-prone houses – it looks like the numbers keep going up – don’t have flood insurance.

A Look at Houston

Houston is a pretty fascinating place. I first started going there in 1996, when the Texas A&M University system hired my firm to be their investment advisor. I worked with them for close to 15 years, I worked with the Texas A&M 12th Man Foundation, the South Texas College of Law.

I would rent a car at Houston Intercontinental Airport, and… I tried to look back and thought of “What experiences did I have in Houston? What are my memories?” and my memories are mostly driving. I would drive around town, I would drive down Interstate 45, amazed at how large the billboard signs were; I would drive around Route 465, the loop over to the Galleria, where I saw my first shopping mall with a skating rink inside… But mostly, I would drive up US 290 and then to Route 6, heading North-West toward College Station, Texas.

It’s a beautiful drive through the Katy Prairie during the season when there’s wildflowers, but just the prairie grass, especially as you head up Route 6. But what I found over the 15 or so years that I traveled is that the exurbs, the suburbs, that new housing subdivisions kept being built out, over and over, further and further from the city.

When I started going to Houston in 1996 there was 4.2 million people in the Houston-Galveston-Brazoria Texas metropolitan area. Now it’s over 6 million, and by 2040 the region is expected to reach 9.6 million residents.

Now, the city (Houston) was started in 1830 by a pair of New York real estate speculators, and they found that it flooded a lot. They had 16 major floods in the first century, yet the city thrived. Now it’s the fourth largest city in the world; it is a job magnet. It’s the center of the U.S. petroleum industry, petrochemicals industry, but it’s still flooded.

A particularly costly flood (this is from a New York Times article) was in 1929, another in 1935… The Harris County Flood Control district was established in 1937. Harris County takes in all of Houston and the surrounding area.

It experienced the highest annual population growth in any county in the U.S. in 8 of the last 9 years. But they had this periodic flooding problem, and that’s just the geography of it. There are now a network of 1,500 channels, a total of 2,500 miles that were built to move storm runoff out of neighborhoods and down to the sea… But Houston is known for having very little (if any) zoning. So there’s not a whole lot of regulation in terms of what gets built where, and as a result, it is a sprawling metropolis.

Paul Krugman, a columnist for the New York Times, recently pointed out that the Greater Houston has less than a third as many people as Greater New York, but covers roughly the same area. Now, there’s a trade-off there, because one of the challenges with Houston is that there was a lot of houses built, and parking lots. In fact, the researcher Erin Kinney of the non-profit Houston Advanced Research Center found that 65 square miles of freshwater wetlands have been lost in the Houston-Galveston area in the last several years, and that 30% of Harris County is covered with impervious surfaces like roads, parking lots and roofs.

So you could never have Houston be as concentrated in terms of density as New York, just because you need the open space for the run-off, for the water to soak into the ground, or at least flow into the sea, and the fact that so many subdivisions have been built, even though there’s more open space, because Houston residents prefer having yards, bigger houses, in a lot of the subdivisions… And that’s just the way it has developed – it has spread out. That’s why when I think of Houston, I think of driving, because I did a lot of driving in the area.

Greg Ip of the Wall Street Journal wrote:

“It’s too soon to know the full economic toll of Hurricane Harvey, but not too soon to predict that it won’t have much impact on Houston’s future economic growth. The storm has extracted such a high price in human misery and economic damage because so many workers and businesses have been lured to the Gulf Coast of Texas, as they have been to coasts around the world. Such areas offer unusual economic opportunities, and no natural disaster will alter that basic reality.”

People like moving to the coast, and that’s where a lot of jobs are. Currently, 2.1% of the nation’s jobs are in Houston. That’s up from 1.6% in 1992. The World Bank reckons that by 2050, 16% of the world’s population will live in large coastal cities, exposed to cyclones, hurricanes, earthquakes, and that’s up from 11% in 2000.

The Thing About Cities

So people are moving to cities, and what I find absolutely fascinating – this is based on a book that I read this past week… It’s called “Scale: the Universal Laws of Growth, Innovation, Sustainability and the Pace of Life in Organisms, Cities, Economies and Companies”, by Geoffrey West. Fascinating book. He outlines why cities are unusual and unique among so many organisms. Most organisms, once they get too big — there is a size where they can get too big. That’s why we don’t have — basically, whales are the largest animal. We don’t have Godzilla-type creatures, because at some point, in terms of animals, as they get bigger, the volume inside of the animal grows faster than their outside exterior, and they need to dissipate heat; that’s part of the law of entropy.

So at some point, a creature gets too big, that it can’t dissipate the heat. That’s why elephants have solved that problem by having very large ears; they can be bigger, but they also have large ears to help dissipate some of that heat. But most things can’t get too big, because as they get bigger, things start to fall apart and they just can’t maintain the size.

But cities are different. Cities scale in a super-exponential way. As they get bigger, they actually get more efficient, and they grow faster the bigger they are. For example, West points out in his book that the gross domestic product per capita in the U.S. (GDP), the measure of how much output is produced, in 2013 was $50,000. So $50,000 per individual.

Metropolitan Oklahoma City has a population of 1.2 million, and its GDP is 60 billion dollars, so essentially $50,000/person. But if we look at Los Angeles, which is ten times larger, it has a population of 12 million, and its GDP is 700 billion dollars, or $58,000 per capita. It’s 15% greater than what would be predicted based on a linear relationship, and that’s where there’s a scaling aspect to them.

As cities get bigger, their wealth per person, their output (or GPD/person) increases. Now, why is that? There’s two reasons. One, as I mentioned, they become more efficient. West says:

“As a function of population size, city infrastructure, such as the length of roads, electrical cables, water pipes and the number of gas stations scales, in a way, essentially, you need less of them per person.”

So you actually get some efficiencies, and it’s called “sub-linear.” They scale sub-linearly, which means that as they get bigger, you need less infrastructure per person, and you gain some economies of scale by doing that.

But at the same time, as cities get larger, there’s the dynamics of social networks that leads to greater wealth creation and innovation. There’s an increasing pace of life. Things just happen faster, new businesses are born and die more often. Commerce is transacting more rapidly. People even walk faster – 15% faster in cities in the bigger towns versus smaller towns… Mainly because there’s just more interaction, more opportunity to be creative, more opportunity to just meet people in your daily working life, and that actually causes some growth, additional creativity.

West writes:

“Cities are effectively machines for stimulating and integrating the positive feedback dynamics between the physical and the social, each multiplicatively enhancing the other. The bigger the city, the greater the social activity and the more opportunities there are, the higher the wages, the more diversity there is, the greater access to good restaurants, concerts, museums and educational facilities, and the greater the sense of buzz, excitement and engagement.

These facts of larger cities have proven to be enormously attractive and seductive to people worldwide, who at the same time suppress, ignore or discount the inevitable negative aspects and dark side of increased crime, pollution and disease.”

In other words, while creativity increase, wealth increases by a greater amount than a strictly linear relationship as a city grows, crime also increases by a super-exponential amount… As does disease, again, because of these social dynamics and more interaction, faster pace in cities.

Now, interestingly, not everything scales in that way in cities. Generally, people still only have one house, so as a city gets more populated, it tends to spread outward, and even the number of businesses per individual. On average, a city and a town have about 21.6 establishments or businesses for every 22 people, with an average of 8 employees. So the number of businesses doesn’t necessarily become larger on a super-exponential basis, but the diversity of businesses in cities — you get greater diversity of businesses because you get more specialization.

I’ve used the term “super-exponential” – what does that mean and how does that differ from just pure exponential growth? Well, exponential growth is just a compound interest formula. It’s the growth that we’re used to experiencing. So if your investment portfolio is increasing at 5% a year, what that means is that the dollar amount of the increase is going up, so the absolute appreciation is going up, but the rate of growth stays the same. That’s called exponential growth.

Super-exponential growth means that both the rate of change and the dollar amount of increase is going up each year. So it’s going from a 5% to a 6% to a 7% growth rate, and that’s when I say super-exponential, because it’s faster than exponential growth. That’s what cities experience because of the fact that as they get bigger, they become more efficient in terms of their infrastructure. It just doesn’t cost as much to maintain the city; so the cost of maintenance goes down per person, yet you have the scaling up of the social dynamics, where you just have more people interacting, becoming more creative, creating wealth, more jobs, and that’s why cities growth at a super-exponential rate.

Can You Plan a City?

When I first moved to Idaho, within a couple years I was sitting on our city’s planning and zoning commission, and it was during a period of extraordinary growth in our town. We are a college town, we have a two-year junior college converted to a four-year college, and developers were coming from all over the place to build apartment buildings.

I remember sitting in my first meeting as a newly-minted planning and zoning member, and the proposal was for an apartment building that was an entire block long. It had no break-ups in the building; basically, the head of the planning and zoning (the chair) called it a lambing shed… An entire city block, one building. And I was amazed there wasn’t any type of design standards in terms of how the buildings should be made. My view was there’s some public good there. We can’t have a city with no zoning at all, but that’s kind of how Houston was, and I’ve gone back and forth.

Jane Jacobs – she was a renowned commentator and researcher on cities, particularly New York. She wrote “The Death and Life of Great American Cities.” She wrote:

“There is no logic that can be super-imposed on this city. The people make it, and it is to them, not buildings that we must fit our plans. We can see what people like.”

Now, Jane Jacobs fought against plowing over much of inner New York, Soho and Greenwich Village for a new highway system. She liked the fact that cities grow organically, and you can’t necessarily plan it out. In fact, she commented on one planner who liked to do planned cities. She wrote:

“His aim was the creation of self-sufficient small towns, really very nice towns if you were docile and had no plans of your own and did not mind spending your life with others with no plans of their own. As in all utopias, the right to have plans of any significance belongs only to the planner in charge.”

So one of the ongoing battles with cities – how much planning should we have? In 1960 a new city was created in Brazil, a new capital called Brasilia. I’m not even sure I heard of this city until I started researching this episode. It certainly isn’t as prominent as Rio. The city was inaugurated in 1960. It was built by 60,000 workers in three years, using one million cubic meters of concrete, 100,000 metric tons of steel; cement had to be air-lifted to the site because there were no roads. This is from a BBC article.

Ricky Burdett, professor of Urban Studies at the London School of Economics says:

“The problem with Brasilia, as with anything new, is that it has some weaknesses. The problem is that it’s not a city. It’s that simple. The issue is not whether it’s a good city or a bad city, it’s just not a city. It doesn’t have the ingredients of a city – messy streets, people living above shops, and offices nearby. It just doesn’t have the complexity of a normal city. It’s a sort of office campus for government. People run away on Thursday evenings to go to Sao Paolo or Rio to have fun.”

The city of Brasilia was set up with very strict zoning, so you had the government workers working in one spot, you had the houses in another, and it was very separated. The city was set up not to have any type of poverty, and in some ways it was lifeless, because cities are messy, they’re complex adaptive systems with a lot of linkages, a lot of unknown linkages, and they evolve over time because of the social dynamics. So it’s very hard to plan a city top-down.

Now, the question is “Should there be any planning at all?” Should it be like Houston, with no planning at all, or should there be — the college town that I lived in, I wanted some planning; I wanted at least the buildings to look nice, but others would argue… Many episodes ago I did an episode where I talked about commodities, and I mentioned Steve’s Gas stations – that’s where I bought gas… And I liked Steve, but Steve and I differ philosophically; he doesn’t think there should be any zoning at all, and used Houston as an example of that, whereas I think there should be some planning, but recognize cities in order to get that super-exponential growth need to be in some regards left unfettered, so that you can have the complexity that evolves over time.

Even a town like Brasilia, or Washington DC, other sort of planned communities at some point they become more attractive as they become more complex and you get organic growth.

The Life of Cities

Here’s the thing about cities – very few die. They evolve over time, and West points out in his book that that differs from companies. Companies do die. He gives the statistics, a study of the 29,000 companies that traded in U.S. markets since 1950 – 78% had died by 2009, including 45% that were acquired or merged, but they no longer existed as independent entities. The vast majority died.

Half of all companies that began trading their stock in any given year have disappeared in 10,5 years. Fewer than 5% of public companies remain alive after 30 years, and the vast majority (99%) are gone within 50 years. So the companies die because in their case, they’re scaling linearly. In other words, the rate of revenue growth relative to expenses, their profit margins tend to be stable, but then if something changes and becomes disruptive in terms of new technologies, then they become vulnerable; they’re not able to adapt, often because companies are controlled by leadership, in the sense that it’s very top-down how companies are run, and as a result, they’re just not as flexible as cities.

West writes:

“The fact that companies scale sub-linearly rather than super-linearly (like cities) suggests that they epitomize the triumph of economies of scale over innovation and idea creation. Companies typically operate as a highly-constrained top-down organization that strive to increase efficiency of production and minimize operational costs so as to maximize profits.

In contrast, cities embody the triumph of innovation over the hegemony of economies of scale. Cities aren’t, of course, driven by a profit motive, and have the luxury of being able to balance their books by raising taxes. They operate in a much more distributed fashion, with power spread across multiple organizational structures. From mayors and councils to business and citizen action groups, no single group has absolute control. As such, they exude an almost laissez-faire, free-willing ambiance relative to companies, taking advantage of the innovative benefits of social interactions, whether, good, bad or ugly.”

Despite their apparent bumbling inefficiencies, cities are places of action and agents of change relative to companies. Cities last, they scale. Companies die, which goes back to why it’s often better to index, because then you’re benefitting from the super-exponential growth of the economy, which is driven by cities and not making specific bets on individual companies, most of which are gonna die; either they’re gonna be liquidated, or they’re gonna merge, or something will come along that may disappoint you as an investor.

Now, there is one other fascinating impact of super-exponential growth in cities, and in Geoffrey West’s book it’s called “Finite time singularity”, and I wish I knew math better… I read a number of academic articles and I’m just not that good at math. He explains it qualitatively, and I understand the concept, but it would be so much better to understand it quantitatively.

He writes:

“Super-exponential growth is unsustainable because it requires unlimited, ever-increasing, and eventually infinite supply of energy and resources at some finite time in the future.”

I talked about super-exponential growth because with purely exponential growth, the rate of change – let’s say the rate of return on your investment – stays the same, the dollar amount increasing, and eventually, it can get to infinity, but it can take a very long time. With super-exponential growth, the rate of growth is increasing, and you see that, as cities scale up – because they become more efficient in terms of infrastructure, at the same time the aspect of social dynamics leads to greater and greater wealth.

It’s super-exponential, but at some point it gets to where the resources — “…if growth were purely exponential, then the production of energy, resources and food could at least in principle keep up with exponential expansion because the characteristics of the economy or city remain finite, even if they continue to increase in size and become very large.”

This cannot be achieved if you’re growing super-exponentially and approaching a finite time singularity. In this scenario, demand gets progressively larger, eventually becoming infinite within a finite period of time. It is simply not possible to supply an infinite amount of energy, resources and food in finite time. So if nothing else changes, this inextricably leads to stagnation and collapse.

Now, the way that we’ve avoided this in the past is new innovations, which essentially reset the clock. Things like iron, steam, coal, computation, digital information – that has allowed this super-exponential growth to continue. But one of the things Geoffrey West points out, and I wish I understand the math better… He says:

“The theory dictates that to sustain continuous growth, the time between successive innovations has to get shorter and shorter. Thus, paradigm-shifting discoveries, adaptions and innovations must occur at an increasingly accelerated pace.”

We recognize cities move faster, and we can recognize in our own life that innovation is occurring more quickly. He’s suggesting that it’s going to continue to have to grow and innovate at a super-exponential rate before the growth gets to infinity and potentially a collapse.”

Now, I don’t have a hard time understanding that. It seems like you could get off the growth path, slow down the growth, but that’s just one of the quirks of the theory of super-exponential growth. I suggest innovation will continue, we’re not going to have a collapse, but it’s something to recognize – one of the downsides to super-exponential growth is you need to continue to innovate at a faster and faster rate in order to reset the clock and continue the growth.

But that’s cities. Cities are absolutely amazing in terms of their adaptability. They last, unlike companies. Unlike us individually, cities continue because they have these really extraordinary social dynamics, as well as efficiencies. A city like Houston, which has taken a big hit – it will come back and continue to thrive, and we’ll see these bigger cities continue to get bigger and bigger, as they are experiencing this super-exponential growth.

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